NRG Energy has become the next Enron on Wall Street. As if the recent repurchase of the spin-off's stock by parent Xcel Energy was not worrying enough, Fitch has cut the debt of NRG below investment grade. One US commentator called NRG "the next overnight bankruptcy waiting to happen".

NRG, however, has responded with a project bond issue that smashes several assumptions about what banks, monolines and peaker plant sponsors can do in the US power market. The $325 million NRG Peaker Finance LLC issue sets a benchmark with which NRG's equally sickly peers could clamber back from the brink.

Advances in peaker plant finance have created one of the low-key success stories of the last twelve months. Shortly after the September 11th attacks both Credit Suisse (a $402 million issue for the Dominion/Peoples'-sponsored Elwood plant) and Citigroup (a $440 million deal for a Northeast Utilities pumped storage plant) led bond financings for peaker projects. Both benefited from sturdier-than-normal debt service accounts and, crucially, rock-solid power purchase agreements (PPAs).

NRG and its bookrunner and advisor, Goldman Sachs, has taken a markedly different approach, both in structuring, modelling and syndicating its debt. The most important aspect of the deal, according to the assistant treasurer and head of project finance at NRG, Nazar Massouh, was the means by which the generator could access a new and previously closed source of capital ? the long-dated bank market.

NRG Peaker Finance contains five plants: Rockford I, Rockford II (in construction but commercial in June 2002), Bayou Cove (in construction with commercial operation scheduled for fall 2002), Big Cajun Peakers and Sterlington. The combined capacity of the plants is 1316MW. The first two plants are located in Illinois and will accompany existing LS Power and CogenAmerica acquisitions, whilst the last three will operate alongside the South Central genco capacity, of which the Big Cajun facilities are the most prominent.

Banks are fairly full on NRG debt. The epic $2 billion construction finance revolver from 2001 exhausted fragile participant banks, and gave NRG committed capital for its construction programme. NRG was fortunate in avoiding paying for a letter of credit to support its post completion equity obligations, and now $750 million is due shortly. The bond markets likewise have been saturated with corporate and genco paper, also subject to downgrade following Moody's decision to cut its rating to Ba1.

Even before the recent downturn in the merchant power finance environment ,NRG had been examining ways to finance a portfolio of peaker plants that would operate in conjunction with its baseload capacity in Illinois and Louisiana. The difficulty in taking assets such as these off balance sheet is that debt providers traditionally dislike the volatile cashflows associated with peakers. These plants exist to take advantage of surges in demand and, crucially, prices. If sited well, they can be very lucrative.

The issue, as Massouh puts is that "project investors have traditionally had a difficult time assessing revenue volatility for peaker plants. Using deterministic scenarios doesn't produce a high value, but the historical evidence shows that these plants can make a lot of money." The task of the sponsor, therefore, was to create a probability-based, rather than a base case, analytical framework.

Such a framework is unprecedented in the power finance community ? and would be a tricky sell to bank or bond investors. The solution was to turn to a monoline insurer, in this instance XL Capital Assurance. The main advantage of using a monoline is that the sponsor only has to negotiate with, and make comfortable, one institution.

XL now carries a triple-A rating from Moody's, S&P and Fitch. It guarantees unconditionally and irrevocably to repay interest and principal on time. In return, it takes a fee and demands that the shadow rating of the deal be comfortably investment grade. In essence, its agreement to underwrite the wrap (although sources familiar with the transaction say it may syndicate some of its exposure) is based on confidence in the statistical models presented to it by the client.

But the NRG deal is almost entirely merchant ? after the first years of an availability-based PPA the portfolio looks to spot sales to cover debt service. The PPA revenues act as a cushion that will protect XL from prolonged exposure to lower-than-expected revenues on the merchant market. Apart from this reserve funding there is little in the way of cash traps, save from a clawback, whereby NRG is liable for excess distributions taken out of the vehicle when revenues are high.

Massouh calls this approach a "volatility monetisation" using a cumulative model. There are no contingent liabilities for NRG to fund, and the structure, aside from the clawback provision, is non-recourse. As far as the ratings agencies are concerned, the deal should have minimal impact on the corporate credit. This last benefit is thrown into sharp relief by the struggle of Xcel to eliminate cross-default provisions between NRG and its parent.

The sell-down benefits from the XL wrap ? indeed as a relatively new player it faces substantially fewer problems with exposure levels than many of its peers. NRG decided to sell the deal not onto the bond market, however, but into the bank market. These institutions are quite happy to book 17-year debt so long as it carries a Triple-A rating. The debt may even end up on the books of project finance groups, several of who will be glad of this weighting tweak to their portfolio. Anecdotal evidence suggests that around 50% of the book was made up of active project finance lenders.

Banks, however, are looking to take on floating rate debt, to match floating rate liabilities. Goldman, through the Goldman Sachs Mitsui Marine Derivative Products affiliate, provided a swap so that whilst NRG pays a fixed coupon, banks receive an interest rate of 107bp over libor. Even taking into account fees for XL and Goldman, this is extremely competitive funding.

NRG may find it difficult to survive the current crisis caused by calls for equity collateral, and signs are that Xcel is looking to distance itself from its previously-acquisitive offspring. The utility business has again become the darling of the family. But the player that brought the banking community the open-ended construction revolver, and may yet bring ruin on its lenders, has sprung one of the year's surprises on an exhausted lending community.

NRG Peaker Finance LLC
Status: closed June 24 2002Size: $325 millionDescription: portfolio financing of three peaking facilities with 1316MW capacityLocation: Illinois and Louisiana, USASponsor: NRG EnergyBookrunner and financial advisor: Goldman SachsMonoline insurer: XL Capital AssuranceRevenue modelling: Henwood EnergyTechnical advisor: Stone & WebsterInsurance advisor: MarshLawyers to the borrower: Latham & WatkinsLawyers to the monoline: Dewey BallantineLawyers to the bookrunner: Skadden Arps